Degree of Operating Leverage The following sales and cost data (in thousands) are for twocompanies in the transportation industry:Company A Company BAmount Percent of Sales Amount Percent of SalesSales $100,000 100% $100,000 100%Variable costs 50,000 50 30,000 30Contribution margin $ 50,000 50% $ 70,000 70%Fixed costs 15,000 40,000Operating profit $ 35,000 $ 30,000Required1. Calculate the degree of operating leverage (DOL) for each company. If sales increase from the presentlevel, which company benefits more? How do you know?2. Assume that sales rise 10% in the next year but that everything else remains constant. Calculate thepercentage increase in profit for each company. Are the results what you expected? Explain.3. In what sense is DOL a measure of risk?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Degree of Operating Leverage The following sales and cost data (in thousands) are for two
companies in the transportation industry:
Company A Company B
Amount Percent of Sales Amount Percent of Sales
Sales $100,000 100% $100,000 100%
Variable costs 50,000 50 30,000 30
Contribution margin $ 50,000 50% $ 70,000 70%
Fixed costs 15,000 40,000
Operating profit $ 35,000 $ 30,000
Required
1. Calculate the degree of operating leverage (DOL) for each company. If sales increase from the present
level, which company benefits more? How do you know?
2. Assume that sales rise 10% in the next year but that everything else remains constant. Calculate the
percentage increase in profit for each company. Are the results what you expected? Explain.
3. In what sense is DOL a measure of risk?
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